November 2006

This book is written by Andy Kessler. It’s a fascinating account of the way in which author runs a billion dollar fund and becomes one of the top performing hedge fund managers in US. But more than that, the book teaches a reader about trend spotting. The biggest factor that he attributes success is “trend spotting”

The first part of the book is about raising funds

Raising Funds is a very hard task as every investor worth his salt would ask for "EDGE". What is your "EDGE" in the investing strategy? Very early in his meetings with various investors, he realizes that he needs to track change of change, the second derivative of change. Change was assumed to be taken by most of the investors and the only way the fund could add value was by focusing on change of change. In the words of Kessler," From the side of highway, you cant tell which cars are moving at a constant speed and which cars are accelerating. But from inside the car, you can feel the seat press against you when you gun it". In essence what he means is, it is easier to sit and give some "HOLD"/ "BUY" decisions on a stock / company.But once you put your money in it, that’s where all the action starts.

In the initial rounds of raising capital for his fund, he is caught in a place where everyone makes a pitch of making up their month. In investment jargon, it means hitting a specific return in a month/quarter/year. The author is caught in a pretty nasty situation where his vision of investing is catching the trend and hitting it big does not gel well with the investors. He also does not want to follow the hedgies strategy of "Short selling". In shortselling, after all your max ROI is only 100%. However if you long some stocks and you get it right, the upside is limitless. Thus Andy has a tough time getting money in to his fund whose investment philosophy is tough to communicate because it is very simple !! " Make money on some strong long term companies" This idea somehow is not taken up enthusiastically by a lot of investors and hence finds himself in a tough position raising funds.

In the second part of the book, Andy narrates his chance meeting with Mr Zed a Zurich investor in a flight. This meeting starts off with an interesting conversation where Zed urges Andy to look back in to Industrial Revolution to get some insights in to Investing. He also understands that long term investing basics are nothing but 3 essential pillarsBig Monster Markets Unfair Competitive Advantage Leverage the Unfair Competitive advantage

Andy then plunges in to the success of Industrial revolution and looks at various forces that shape the industrial revolution.

• There was a demand for machines but making machines was unthinkable because natural iron didnt exist • Heating iron ore directly with charcoal gave rise to a weak iron • Abraham Darby invented smelting process using coke and then demand for coke and iron ore took off. However the mines from which iron ore was getting extracted was a dangerous activity as mines were often below water table • Thomas Newcomen designed steamengine which could lift 2 tons of water. Technology was pathetic though • James Watt then used condensor to make it more efficient • British Parliament gave the patent to Watt • Funding was obtained from Matthew Boulton • Wilkinson was asked to produce cannons as Kind desperately needed it and he had a tool which could do precision boring • Wilkinson, Watt and Boulton came together and then the steam engine found some use • However it was difficult to sell steam engines as they were very costly • To put the steam engines to use, Boulton traveled all around US and basically tried to sell a technology replacing horses. Pricing mechanism was simple..1/3 cost of horses which were used for performing the task

Did the business take off ? Not really …It required a monster market to really take off. And it came in the form of textiles. There was an enormous development happening in the textile industry, primarily because the process of creating textiles was a cumbersome process and there were some developments that were starting to see the light of the day.Eli Whitney was the person who developed Cotton engine and that was the tipping point. 1792 – Cotton gin was invented, 150,000 pounds of cotton was made1800 – 17 million of cotton1850 – 700 million of cotton2003 – 5.6 billion of cotton5000 growth in the first 58 years and then it grew by a factor of 8 over the next 150 years..0 followed by 100 zeros 1 %One has to be early on these trends

Probably the best philosophy from this book has been in this section :Hunt for rivers which break barriers. Barriers are broken by the intense pressure of change behind them, cutting through everything in their path, accelerating at will. Young rivers cut through like a hot knife through butter.Old rivers meander. They don’t make cuts..They merely follow the paths created by the gushing rivers. and more importantly , Meandering rivers don’t scale.

In the third part of the book , Andy talks about scale. Scale happened through out 1807 till 1906. A series of developments one after another triggered the business• River Streamerships • Steam Locomotives and rail roads • Ocean Steamships and propellers • Suez Canal • Turbine • Scale – 1800 to 1900• River Steamships• Steam Locomotives• Ocean Steamships• Suez Canal• Turbine

Andy received the first success by picking General Magic, a voice recognition company. Other successes were Inktomi and Real Networks. However the fund gets a beating because of currency fluctuations. Andy still believes in US firms but not blindly. He gets a chance to invest in mp3.com but desists from doing so, as he believes its not a company with sound fundamentals. and Market Rightly says the same thing subsequently.Keeping the simple philosophy of finding young rivers which scale, the fund slowly grows bit by bit to 1 B, yes Billion dollars in a matter of 2 years.

Stocks are voting mechanisms, a collective vote of expectations of company’s fundamentals. Andy really believes that short term blips should not unnerve a fund manager. The book has an excellent chapter on Netscape and I did not knew earlier that the biggest reason why Netscape failed to take off was :Jim Barksdale , the then CEO of the company buying Collabara, a competitor to IBM scared the shit out of IBM and stopped shipping Netscape . Switching to IE sealed Netscape’s fate.

Just when the tech was about to bust, Andy figured out that it was better to be out of the play and he slowly started returning the money to the investors and just managed to get out of crash..U can call him lucky, U can call him astute.But the fact that he came out unscathed from the bust. This part of the book also talks about Margin Surplus. There is generally a lot of talk about US carrying a huge trade deficit and would be harmful in the long run. However Andy clearly says that it is margin that matters. In a simple example of PC, Intel exports $ 350 chip and makes $300, Windows sells OS for $50 and makes $49.99 on it.While Asian countries assemble it and then sell it back to US for $1000, their margin is only 50 bucks..What d o they with $1000. They try to find the best investment for the capital and somehow the capital finds its place funding the innovation in US. So, trade deficits don’t matter, atleast that’s what Andy thinks.

The book ends with Andy Kessler saying that he studies people and not just technology and numbers. This resonates with Trader Joe’s founder’s philosophy too.For building a successful business, one has to be an ardent anthropologist, though not in the professional sense.

Overall, I loved this book for many reasons.But I guess one of the lines in the book summarizes the rhythm of the book, “ If you want to make numbers only every quarter, stick to walmart…Investing to get a multi baggers is not for the weak hearted”

Takeaway from the book : Hunt for rivers which break barriers

PS : Some of his investments in Andy’s fund which hit home run are General Magic, Inktomi, Real Networks. He never invested in mp3.com inspite of the so many analysts touting it as the next big thing

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